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Introduction to economic growth, unemployment and inflation. Main macroeconomic goals. objectives. Define two measures of economic growth Explain why growth is a desirable goal Identify two main sources of growth Explain what is meant by a business cycle
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Introduction to economic growth, unemployment and inflation Main macroeconomic goals
objectives • Define two measures of economic growth • Explain why growth is a desirable goal • Identify two main sources of growth • Explain what is meant by a business cycle • Discuss how unemployment & inflation are measured • Discuss the types of unemployment & inflation and their economic impacts
Two measures of economic growth • The increase in real GDP, which occurs over a period of time. • The increase in real GDP per capita, which occurs over time. This definition is superior if comparison of living standards is desired. • Real GDP per capita equals real GDP divided by population of a country • Growth in real GDP does not guarantee growth in real GDP per capita. If the growth in population exceeds the growth in real GDP, real GDP per capita will fall.
Growth is a desirable goal • Growth is an important economic goal because it means more material abundance and ability to meet the economizing problem. Growth lessens the burden of scarcity • Main sources of growth are increasing inputs (land, labor, capital & entrepreneurship) or increasing productivity (real output per unit of input) of existing inputs. • Productivity rises due to improvements in health, education & motivation of workers
Phases of the business cycle • Business cycles – alternating rises & declines in the level of economic activity • A peak is when business activity reaches a temporary maximum with full employment and near-capacity output – price level likely to rise. • A recession is a decline in total output, income, employment, and trade lasting six months or more. • The trough is the bottom of the recession period – employment & output at their lowest levels. • Recovery is when output and employment are expanding toward full‑employment level
The Business Cycle Peak Peak Trend Peak Expansion Growth Level of Real Output Recession Expansion Trough Recession Trough Time
Causes of business cycles • Recall – fluctuations are driven by shocks – unexpected events that individuals & firms may have trouble adjusting to. • Price stickiness prevents the economy from quickly adjusting to shocks • Types of shocks responsible for Business cycles (several theories) • Major innovations/inventions like railroad, automobiles, the internet – have large impact on investment & consumption spending • Productivity shocks – unexpected productivity shocks, economy booms • Monetary phenomenon – print too much money than agents expected, inflationary boom • Unexpected financial bubbles & bursts, spillover through optimism & pessimism to affect the production of goods & services • Unexpected political events like wars • Irrespective of the cause economists agree that the immediate cause of majority of cycles is unexpected changes in total spending
Macroeconomic Maladies Unemployment & Inflation
Measurement of unemployment • When measuring unemployment, the population is divided into three groups: • those under age 15 or institutionalized (army, mental hospitals, school), • those “not in labor force,” and • the labor force - includes those aged 15 and 64 who are willing and able to work, and actively seeking work (demonstrated job search activity within the last four weeks). • Size of the labor force depends on: • Total size of the population of the working age; the number of people who remain in full-time education after leaving secondary school; the normal retirement age of males & females; number of women who join the labor force on full-time or part-time basis • The unemployment rate is defined as the percentage of the labor force that is not employed. Give example
Measurement of unemployment • Unemployment rate = (unemployed/labor force) x100 • Suppose, stable population = 120; labor force = 100; employed = 95; unemployed = 5 people • Calculate unemployment rate • The unemployment rate = (5/100)x 100 = 5% • Calculation of unemployment rate can be based on survey data: Two factors cause the official unemployment rate to understate actual unemployment. • Part‑time workers are counted as “employed.” • “Discouraged workers” who want a job, but are not actively seeking one, are not counted as being in the labor force, so they are not part of unemployment statistic.
Types of unemployment • Frictional unemployment consists of those searching for jobs or waiting to take jobs soon – may result from: • Changes in seasonal demand; moving to better paying jobs; recently fired; recently completed studies • Structural unemployment: due to changes in the structure of demand for labor; e.g., when certain skills become obsolete or geographic distribution of jobs changes. • Occupationally – demand for certain skills, such as typing, making horse shoes, may decline while maintaining computers increases. If composition of labor force does not respond quickly - unemployment • Cyclical unemployment is caused by decline in total spending associated with the recession phase of the business cycle • As firms respond to insufficient demand for their goods and services, output and employment are reduced (its more serious than the other two)
Full employment • Full employment does not mean zero unemployment. • The full‑employment unemployment rate is equal to the total frictional and structural unemployment. • The full‑employment rate of unemployment is also referred to as the natural rate of unemployment (NRU). • It occurs when the economy is producing its potential output • The natural rate is achieved when labor markets are in balance; the number of job seekers equals the number of job vacancies • Underemployment – A situation in which a worker is employed, but not in the desired capacity, whether in terms of compensation, hours, or level of skill and experienceDisguised unemployment - When more people are engaged in some activity than the number of person required for that
Costs of unemployment • Economic costs • Forgone output or output (GDP) gap • GDP gap = actual GDP – potential GDP • Okun’s Law – for every 1% increase in unemployment rate a negative GDP gap of about 2% occurs. • Unequal burdens of unemployment exist • Rates are lower for white‑collar workers. • Teenagers have the highest rates. • females have higher rates than males (Botswana). • Less educated workers, on average, have higher unemployment rates than workers with more education. • Non-economic costs • Poverty, loss of skills & self‑respect, family disintegration, social and political unrest
Inflation • Inflation is a rise in the general level of prices (but not all prices rise at the same rate, and some may fall). • The main index used to measure inflation is the Consumer Price Index (CPI). • Inflation(2012) = {[CPI(2012) - CPI(2011)]/CPI(2011)}x100 • Suppose CPI(2012) = 198; CPI(2011)=190; Inflation=? • Inflation(2012) = [(198-190)/190]x100 = 4.21%
Types of inflation (2) • Demand‑pull inflation: caused by an excess of total spending beyond the economy’s capacity to produce, i.e., spending increases faster than production. Often described as “too much spending chasing too few goods.” ex. Over-issuance of money by central bank • Cost‑push or supply‑side inflation: Prices rise because of rise in per-unit production costs (Unit cost = total input cost/units of output). • Output & employment decline while the price level is rising. • Supply shocks have been the major source of cost-push inflation. That is, dramatic increases in the price of raw materials or energy. Give examples • Cost-push inflation generates recession
Effects of inflation • Inflation hurts some people, leaves others unaffected & helps others. So, inflation redistributes real income from some people to others. • Real income = nominal income/price index • Real income is a measure of the amount of goods & services nominal income can buy • Redistributive effects of inflation • Fixed‑income groups will be hurt because their real income falls. Their nominal income does not rise with prices. • Savers will be hurt by unanticipated inflation, because interest rate returns may not cover the cost of inflation. Their savings will lose purchasing power. Give numerical example • Debtors (borrowers) can be helped and lenders hurt by unanticipated inflation. Interest payments may be less than the inflation rate
Effects of inflation • Output effects of inflation • Cost‑push inflation could cause both output and employment to decline. Real income falls. • Demand-pull inflation – no consensus among economists • Mild inflation (<3%) is good coz results from strong spending, which in turn creates high profits, strong demand for labor & incentive to expand plant size • Makes it easier for firms to adjust real wages downwards in the face of weak demand for their products (hold nominal wages steady) • By contrast – may reduce output by diverting time & effort toward activities designed to hedge against inflation (menu costs, information search, people limit amount of money they hold) • Hyperinflation, which is extraordinarily rapid inflation, can cause speculation (people expecting even more rapid inflation), leading to reckless spending, and more inflation – disrupts normal economic relationships.
Unemployment & inflation management • Governments use two main policies to manage unemployment & inflation – Fiscal policy & monetary policy • Main purpose of these policies is to influence aggregate expenditure/demand. • If the country faces high unemployment as during recessionary phases of the business cycle government can use either an expansionary fiscal policy or expansionary monetary policy to boost aggregate expenditure/demand • If the country experiences high inflation, government can use either contractionary fiscal policy or contractionary monetary policy to dampen aggregate expenditure/demand
